If you have children or grandchildren you may have heard of 529 Plans. If you are planning on paying, or helping to pay for the college education of a loved one, the 529 Plan is a great option. Established in 1996, these are college savings plans, similar to Roth IRAs and named after the Internal Revenue Code section that governs them.
There are two types of 529 Plans – Prepaid Tuition Plans and Savings Plans. Prepaid tuition plans are just as they sound. They allow you to lock in future tuition at today’s rates for state specific schools. The savings plans are investment vehicles the can be used for future qualified expenses.
You can use 529 plan funds at almost any accredited college or university. The savings plans can also be used for accredited trade and technical schools. The recent Tax Cuts and Jobs Act also allowed, at least at the federal level, of distributions from 529 plans to be qualified to pay up to $10,000 a year toward K-12 education expenses. Most states have yet to decide if they will also treat these distributions as qualifying distributions or will subject the earnings to tax.
The reason we referred to 529s as like Roth IRAs earlier is because 529 plan investments grow tax exempt, just as a Roth IRA does. If the distributions are used for qualified expenses – tuition, fees, room and board, books or supplies – the earnings of the account are not subject to tax when withdrawn. If not used for qualified expenses, the earnings are taxable, but not the original contributions.
The definition of qualified expenses for 529 plan distributions is much more generous than the usual definition for education credits. We are still waiting to hear from the states how they will treat 529 distributions used for K-12 expenses, but at a federal level, those distributions will be considered qualified as well.
Whomever purchases the 529 plan is the custodian and has control of the 529 plan funds until they are withdrawn. There can be only one designated beneficiary per plan, however the beneficiary can be changed to another member of the beneficiary’s family with no tax consequences. You can also roll funds over from one child’s account to their sibling’s account without penalty, in a trustee to trustee transfer.
Anyone can set up a 529 plan, however your state may have certain limitations. You can also name anyone as a beneficiary – a relative, friend or yourself! Unlike IRA accounts, there are no income restrictions for contributions and no limit to the number of plans you can set up. If contributions are made to any one beneficiaries account over the annual gift tax limits, a gift tax return may be required to be filed, but an election can be made to spread the gift out over 5 years.
One advantage has already been mentioned: contributions grow tax-free, as long as the distributions are used for qualified expenses. Start investing early and you can take advantage of compounding – where money you earned, earns money!
Some states allow for deductions on your state tax return. For instance, Virginia allows for up to $4,000 deduction from taxable income, per contract. So, each parent can set up a contract for each child, make a $4,000 to each one and reap the benefits. Any contributions in excess of the $4,000 limit are carried forward for deduction in future years.
Celebrate 5/29 Day – National College Savings Plan Day
To encourage contributions to state 529 plans, many states are offering incentives to establish an account. I have linked to a few below and this article on Savingforcollege.com highlights a few other states promotions.
Open an Invest529 account between May 22nd and May 31st with at least $50 and a $50 recurring bank debit and receive $50. Visit https://www.virginia529.com/in-the-community/529-day/ for details.
Maryland account holders with taxable income within certain parameters may be eligible for a contribution of $250 or $500 from the state. Applications are due June 1, 2018. Visit https://maryland529.com/mdmatch250